Failure to Bury ‘Transitory' Inflation Narrative Risks Sparking Biggest Fed Error in Decades

Failure on the part of the Fed to toss its stubbornly-held "Transitory" inflation narrative and act more decisively to rein in persistently high price pressures raises the likelihood the central bank will need to slam on the brakes of easy money policies much more forcefully down the road, risking avoidably severe disruption to domestic and global markets, according to Queen's College President and economist Mohamed El-Erian.

Consumer price inflation is running at around a 30-year high and well beyond the Fed's 2 percent target, to the consternation of central bank policymakers who face increasing pressure to roll back stimulus, even as they express concern that the labor market hasn't fully rebounded from pandemic lows.

Besides measures of inflation running hot, consumer expectations for future levels of inflation have hit record highs, threatening a de-anchoring of expectations and raising the specter of the kind of wage-price spiral that bedeviled the economy in the 1970s.

El-Erian, in the op-ed, argued that the Fed has "Fallen hostage" to the framing that the current bout of inflation is temporary and will abate once pandemic-related supply chain dislocations will abate.

El-Erian said he fears that Fed officials will double down on the transitory narrative rather than cast it aside, raising the probability of the central bank "Having to slam on the monetary policy brakes down the road-the 'handbrake turn.'".

Some Fed officials have said that, if inflation stays high, this supports the case for an earlier rate hike.

Fed Governor Christopher Waller recently suggested that the central bank might need to introduce "a more aggressive policy response" than just tapering "If monthly prints of inflation continue to run high through the remainder of this year."

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